News Analysis date published New: 
Friday, September 28, 2012 - 08:30
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Friday, September 28, 2012 - 15:19
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Friday, September 28, 2012 - 08:30

Looking for an Election Investment? This Isn't it...

Friday, September 28, 2012 - 8:30am

What's the first thing people do when they hear about major shootings by a mentally unstable gunman? They go out and buy guns. These shocking news events tend to spook people, so they instantly take steps to ensure they don't fall victims to the next shooter. As an example, gun sales in Arizona rose 60% on the day after Congresswoman Gabrielle Giffords and others were shot on Jan. 8, 2011, according to the FBI's National Instant Criminal Background Check System.

More broadly, gun sales have been above historical trends ever since President Obama took office. Supporters of the Second Amendment to the Constitution have suggested that the Obama administration would make it much more difficult to acquire guns, so they loaded up on firearms in advance of any tighter measures.

Though tighter gun regulations never took effect, sales surely benefited anyway. And for gun maker Sturm Ruger (NYSE: RGR), it's been a boom time, as shares have risen roughly 1,000% since late 2008. Indeed shares have risen a solid 30% since my colleague Michael Vodicka profiled the company in late June.

Yet the road ahead for Sturm Ruger may prove to be much bumpier. At least according to short sellers. They hold 7.8 million shares in their accounts, which equates to a stunning 42% of the stock float and represents roughly 19 days' worth of trading volume. (Short data as of Sept. 14, 2012, which was released on Sept. 25, 2012.)

Why are the shorts making such a big bet? Well, a few key issues come to mind.

The first is a matter of competition. As Sturm Ruger gained in popularity with gun owners, rival Smith & Wesson's (Nasdaq: SWHC) fortunes seemed to wane. As a result, shares of Sturm Ruger rose ever higher during much of President Obama's presidency, while shares of Smith & Wesson slumped.

Yet as I noted earlier this month, Smith & Wesson appears to be back on track, delivering fiscal first quarter earnings per share results that were more than 50% ahead of forecasts. Management boosted forward guidance so sharply that analysts now expect fiscal (April) 2013 sales to rise 30% to $536 million.

In effect, Sturm Ruger can no longer count on a sleepy rival, and short sellers may be predicting market share shifts ahead.

A saturated market?
An even bigger concern than relative market share is the total size of the market. While conventional wisdom holds that another victory for President Obama this fall will usher in another streak of strong gun sales in 2013 and 2014, analysts aren't so sure. They see both of these companies boosting sales at a very modest pace: Sturm Ruger's sales are expected to grow just 0.4% to $459 million in 2013. For Smith & Wesson, the fiscal year that begins next May should also represent slowing growth, with sales rising just 4.5% to $561 million.

Why would gun sales slow even if a president who's seemingly hostile to the gun lobby is re-elected? Because many gun owners may have all the firearms they need. Guns don't wear out quickly, so this isn't an industry that benefits from a replacement cycle. Short sellers may be signaling that gun sales may not just be flattening in the years to come, but poised to move lower as gun owners decide they are already amply protected against the next mentally unstable shooter making the headlines.

Risks to Consider: As an upside risk for short sellers, a certain segment of gun owners say the Obama Administration will seek to comply with a United Nation's push to tighten gun control law, as this piece from NPR notes. So any headlines along those lines could lead to another spike in gun sales.

Action to Take --> It's increasingly questionable whether a re-election of President Obama will presage another spike in gun sales. A victory by Mitt Romney, which looks less likely at the moment, would surely remove the impetus for fears of Second Amendment infringement. The firearms sector has had a great run, augmented by the fact that Smith & Wesson is regaining a bigger slice of the market. And that's precisely why short sellers are betting that Sturm Ruger's best days have already passed.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.